A new take on impact of foreclosures on home values

A distressed home has a negative effect on the neighborhood even before it enters foreclosure. (Joe Raedle/ Getty photo)

There's good news and bad news to be found in the latest research regarding the effect of foreclosed homes on neighborhood property values.

The upside is the financial dents that distressed properties make on nearby home sales aren't nearly as deep as thought in some previous studies. In fact, they are "economically small," according to the working paper from the Federal Reserve Bank of Atlanta.

But here's the rub. Researchers also found that homeowners are wrong to start worrying about a decline in their own property's value when a nearby home goes into foreclosure. Actually, their home values start to slip when the neighbors start skipping mortgage payments, months before the home officially enters foreclosure.

Because of that finding, the study's four authors, two from Federal Reserve banks and two from Fannie Mae, argue that policies adopted to stretch the amount of time a home is in foreclosure don't necessarily benefit borrowers but they do cost society.

In the past five years, research into the spillover effects of foreclosures has gotten a lot of attention, and various studies have pegged the blow to nearby property values at anywhere from half a percentage point to more than 8 percent.

"I've always been very skeptical of this literature, skeptical of the methodology they used," said Kris Gerardi, a financial economist and associate policy adviser at the Atlanta Fed who co-authored the paper. "I thought studies were overestimating the effect."

So the authors, who included Chicago in their study, looked at repeat sales of properties, with the first sale after 2001 but before the housing crisis and the second sale taking place somewhere between 2006 and 2010.

It also obtained data not just on foreclosures in each of the 15 cities studied, but on properties where the borrower was not yet in foreclosure but the mortgage was seriously delinquent, no payment having been made in 90 days.

What the data showed was that homes near a distressed property do indeed sell for a lower price, regardless of whether the home's mortgage is merely delinquent, whether it is bank-owned or whether it was recently sold by the bank to another party. However, the negative effect on pricing amounts to only 0.5 percent to 1 percent for a home that is within 0.1 mile of a distressed or bank-owned home.

"To a homeowner, if you've got one distressed property in your area, you're not going to notice it," Gerardi said. "But if you've got five, 10 properties around you, and homeowners aren't keeping up with maintenance, that could affect you."

The researchers also used their results to suggest that various policies that allow homeowners to linger in serious delinquency and foreclosure exacerbate the costs to nearby homeowners and communities.

In the Chicago area, it takes an average of more than 600 days for a distressed home to move from initial default notice to bank-owned.

That doesn't include the number of days the home's mortgage is delinquent before lenders start proceedings to repossess the property.

"Some of these policies have just shut down the pipeline," Gerardi said. "They've prevented mortgages from exiting the pipeline. One of the takeaways from this paper is that's not necessarily helping the neighborhood from a values perspective.

"You're shifting mortgages from (bank-owned) to persistently in the foreclosure process. Distressed properties in all states of distress seem to have a very similar impact on nearby home values."

When bad news is good. A recent measure of home affordability slipped a bit in the Chicago area. During the second quarter, 74.6 percent of homes were considered affordable for families with the area median income of just above $77,000, down from 78 percent in the first quarter.

Affordability fell nationally, too, according to the index from the National Association of Home Builders and Wells Fargo.

The industry group's take on the data is that the decline is a positive development because it shows that prices are moving up and that's something that might move homebuyers and sellers from the sidelines into the market.